Corporate risk management begins with purchasing
By Paul Teague, Editor in Chief -- Purchasing, 7/14/2007 2:00:00 AM
If the subject wasn't so serious, the following true story of faulty commodity forecasting and lack of supply chain risk management would almost be funny:
An airline company, which shall remain nameless, used a particular kind of screw to hold down the toilets on its planes. The company's spend on this item was miniscule. It used only one supplier for the screws, a company in Arkansas run by a father and his three sons. The supplier's normal routine was to manufacture screws 10 months of the year and take the other two months off to go hunting. Wise customers knew they should order enough to get them through the two months when the plant would be closed. Not aware of the supplier's long-established routine, new management at the airline company didn't order enough and instead went on an inventory-reduction binge. Of course, the company ran out of its supply. Result: Several planes were grounded for days for want of a screw. In a panic, the airline company eventually found another source of supply, but was forced to pay $18 for each screw when the normal cost was $1.
When you're through laughing, think about the lessons in this admittedly outrageous example, which comes from Kevin McCormack, CEO of DRK Research, who is writing a book with Robert Handfield entitled "Supply Chain Risk Management: Minimizing Disruptions in Global Sourcing." Lesson one: Reducing inventory is good, but you can carry it too far. Lesson two: Even the most insignificant component can cause big problems if you can't get it.
Anticipating and managing risk is essential for supply chain continuity, and it's a critical skill for procurement professionals today. It's inherently tied up with forecasting and supplier intelligence. The importance of both was evident last month when Boeing, which has a very professional purchasing organization, found it couldn't get enough of the required nuts and bolts for its 787 Dreamliner. But lack of components or raw materials is only part of the disruption that comes from forecasting or supplier miscues. Revenue and profit can take a hit too.
Bottom-line effects
In their 2005 study of the financial effect of supply chain disruptions, Kevin Hendricks, formerly of the University of Western Ontario, and Vinod Singhal, of the Georgia Institute of Technology, made some interesting findings. They discovered that the average effect of supply chain disruptions in the year leading to the disruption included a 107% drop in operating income, 7% lower sales growth and 11% growth in cost. Share price volatility in the year after the disruption was 13.5% higher than in the year before disruption.
Give those statistics to anyone who says supply chain management doesn't affect the bottom line.
Obviously, risk management is everyone's responsibility in corporations. But, it begins with purchasing. As manager of the supply base, purchasing has to be sure that suppliers' interests align with their interests and that the suppliers are financially able to service them. Only knowledge like that can avoid situations like the one faced by a medical-device manufacturer which recently was surprised to find that the single-source o-ring supplier for one of its implantable devices would not supply the part anymore. The reason: the high liability costs. The device manufacturer had to stop shipping product until it could certify a new supplier, which, of course, took time.
Hopefully, surprises like that are rare. But, a 2005 Aberdeen study found that 55% of companies surveyed had not developed the kind of strategic approach to supply risk management that anticipates that and other surprises. If your company is one of them, you should start developing a plan now.
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